Market Remains Little ChangedThere was nothing really new of not in the market this week with the exception of the further weakness in the financial sector. LIBOR Overnight rates more than doubled this week, ending just shy of 0.24% after starting the week just above 0.1%. While this is nothing compared to the rates back in September, the signal that is being sent by LIBOR is that banks are once again in danger. This showed up in the weekly sector trends, showing that Financials are getting weaker while Energy and Industrial Materials are getting stronger.
This market is now fully on Stimulus, TARP, and Obama watch. The second part of this update will be about the stimulus package, and why it is going to fail regardless of the plans or ideology used in the proposals. The market is now setup in a very tight trading range, 8150 to 7950 on the Dow, and it will likely stay stuck in that range next week, likely closing at the higher end of the range. A break out of breakdown is possible, especially with fourth quarter GDP numbers being released. A surprise with that number to the up or downside will likely give the market direction, however an inline number will keep us stuck in the very narrow range.
Why the Stimulus Will FailI know a lot of people will take this section as Democrat bashing or me wishing that Obama will fail. It is nothing of the sort, neither the typical Democrat bottom up approach or the Republican top down approach will actually be able to stimulate the economy in large enough scale to out weigh the cost of the plan. Here is why...
Top Down Approach:Regan coined the top down approach "Trickle Down Economics" and the general approach is that you reduce the cost on corporations and small business through tax breaks, tax credits for investments and employment, and other such business favorable treatment. The theory is that under such conditions businesses will hire more people, produce more good and services, which eventually gets into the hands of consumers which spend money on those good and services.
However, in the current economic conditions any stimulus pushed into the top down approach will not reach the required money velocity in order to overcome the debt created by the stimulus. The reason for this is simple, businesses have limited visibility in terms of future economic conditions and while some businesses will take the leap of faith into the unknown and attempt to expand, most businesses are currently highly adverse to risk right now. Just like the banks, businesses will horde cash in the current economy creating no flow of money, resulting in no stimulus at the cost of future debt and growth.
A Top Down plan could come with stipulations that any money received from the government would have to be invested and not horded. The problem with this, as it will be with the banks being required to lend the money as part of TARP 2, is that such stipulations will create an environment where only the weak hand will access the money. Putting more and more money into weaker and weaker hands will only result in the money getting lost in a black hole, totally unaware as to where it actually ended up. Think of the AIG where Billions and Billions are just lost, or GM where Billions and Billions are needed to just keep the company afloat.
Bottom Up Approach:A plan normally favored by Democrats, the theory behind it is simple, put more money in the hands of the consumer (the little guy) and they will go out, spend money on goods and services, this will intern get businesses to spend money to offer these consumers those goods and services. The problem with this approach is that consumers have no incentive to spend in the current economy, and with every dollar they save becoming worth more (an Issue Japan has been dealing with for a long time). The $500 tax credit will amount to $10 extra a week, which most consumers will either save or use to pay down debt. People are not going to spend anymore than they have to. Even the people that spend their $10 a week will most likely be on Gas or another product that is not produced in this country, serving to send much of the stimulus to another country. As with the Top Down Approach, the money velocity is not great enough to cover the long term cost of any money dumped into this approach.
Infrastructure:Investment in infrastructure will also fail to meet the required money velocity in order for the short term stimulus to outweigh the longer term cost. The stated goal of the administration was to spend 50% of the infrastructure investment by the end of 2010. That is just too little money to slowly to actually have a stimulative effect. In fact the plan would be better served to slowly spend the money, giving those that do get a job building this infrastructure the assurance and confidence that they will have a job for many years. Not just a three or six month contract to repave a road. Investment in infrastructure is the most worthwhile goal of the stimulus package, but the effects will not be the short term stimulus that the plan desires.
The Problem: Service EconomyThe root of our economy problem is a simple one, and that is the US is a service based economy. Such economies work great when everyone is buying goods and services and money is flowing freely and being created. However, problems arise when services (such as eating out, getting pedicures, etc) stop being used. When you do not produce many of the goods that are bought much of the money velocity that needs to stay in the economy gets shipped off to the countries that do produce those goods. This is why the US has record deficits and countries like China have record surpluses. Service based economies are financed by debt, but that bubble is now gone. However, we are not facing that reality and the US Government is trying to keep the debt bubble going by financing growth with debt, just as consumers have done for many years now.
So What Needs to Happen?Simple: Time. The economy needs to be given time to reach its point of equilibrium. Yes, this point will likely have unemployment north of 12-15%. Yes, reaching this point will be highly deflationary. Yes, reaching this point would be a highly painful and long process. The economy will reach this point of equilibrium by itself, with our without government stimulus. The debt bubble is bursting, and the government needs to wake up to that fact. Just as Americans everywhere have been forced to stop living on borrowed funds, so too must the US Government at some point. Failure to do so will only delay and lengthen the painful process.
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